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06/26/2006

On Agricultural Subsidies by Rich Countries-BECKER

A report due out at end of July on agricultural policies in countries that belong to the Organization for Economic Cooperation and development (OECD) quantifies the extensive government subsidies farmers receive in these countries. These subsidies amount overall to about 29% of their farm revenues. This per cent varies considerably: from highs of 68% in Switzerland, 64% in Norway, and 56 % in Japan, to "only" 16% in the US, and a relatively low 5% in Australia. The beautiful views of cows and sheep on the very green Swiss mountains are courtesy of the Swiss government that pays farmers generously to keep these animals grazing on the mountains.
Developing nations object to the farm subsidies by rich countries because they make it difficult for farmers in their own countries to compete in the world markets for agricultural goods. The European Union has high tariffs against farm imports from countries outside the Union, while the US gives significant export subsidies to its agricultural products. Most rich nations have direct payments to farmers when agricultural production increases, and they also help subsidize the cost of water, seed, machinery, and other farm inputs.
Farm subsidies are the main complaint lodged by developing nations against the trade policies of developed nations in the ongoing Doha talks on more open international trade. Richer nations in turn complain about the many barriers to imports of Western and Japanese goods erected by poorer nations. Both sides are right, but the US and other rich nations should greatly liberalize their farm policies irrespective of whether developing nations lower their trade barriers. The reason is not mainly to help poorer nations, although it would do that in a way that adds to world economic efficiency and trade. Freeing agriculture would also help consumers and even many farmers in rich nations.
Whether subsidies to agriculture raise or lower prices to domestic consumers depends on the form the subsidies take. Restrictions on imports of farm goods clearly raise domestic farm prices by cutting back access to farm products from more efficient producers in poorer nations. Subsidies to farm exports also raise domestic prices by artificially diverting production from the domestic to the export market. Subsidies to farm inputs like water encourage excessive use of water compared to other inputs. This is partly through inducing farmers to shift production toward crops that use a lot of water, such as rice, and away from crops that use little water. The result is lower prices for water-intensive crops, and higher prices for water-sparing crops. The OECD report estimates that more than half of the farm subsidies in member nations are through policies that raise domestic prices of agricultural goods.
The argument is sometimes made that farm subsidies are desirable to encourage small farms, and the way of life on these farms. Yet this claim is contradicted by the evidence available for many decades, and confirmed again in the OECD report, that the vast majority of subsidies go to the largest farms. In many cases they are given to people who own but do not farm their land.
Another argument in defense of farm subsidies is that they contribute to a better environment. Some of the subsidies may do this by reducing population density and pollution, but many others add to environmental damage. For example, subsidies to irrigation and other water use by farmers is one of the major ways that fresh water is wasted. Environmental and geopolitical arguments are used to justify the large subsidies to ethanol production from corn in the US. Ethanol helps reduce the West's dependence on oil because ethanol is a substitute for gasoline. GM and other companies are beginning to promote E85, which means 85% ethanol and 15% gasoline. Automobile fuel tanks can easily be modified to take this combination, but the US still has only a small number of gas stations that have the expensive equipment to dispense highly ethanol-intensive fuel.
Ethanol not only reduces dependence on oil imports, but also ethanol based fuel cause less pollution than gasoline does. Ethanol probably also uses less energy, although that is debated since both the plants that produce ethanol, and the fertilizers that help to grow corn, use considerable quantities of natural gas. The US has subsidized ethanol production from corn primarily to help corn growers rather than to reduce energy use since it is combined with a steep tariff on imports of ethanol from elsewhere. These imports would come mainly from Brazil that produces ethanol from sugar cane at a much lower cost than the US production from corn. Instead of subsidizing domestic production of ethanol, a much wiser policy for the US would be to eliminate these tariffs and import ethanol from democratic and friendly countries like Brazil that can produce ethanol more cheaply.
The economic case for eliminating farm subsidies by rich countries is a compelling one since these subsidies are inefficient, generally raise food prices to consumers in these countries, and anger developing countries that see their natural markets blocked. Yet while economists have been rather united in their criticisms of agricultural policies, the farm lobby has been powerful, especially in Japan and many European nations. This is despite the fact that farmers in most rich countries constitute no more than a tiny percentage of the labor force.
It may seem paradoxical that farmers are typically rather heavily taxed in poor countries, like India and China, where they constitute a large fraction of the population, and are subsidized in rich countries dominated by cities and towns. But the economic analysis of interest group politics demonstrates that small groups are often much more powerful politically than large groups, even in democracies where large groups would seem to command more votes. The explanation is that small groups may be organized more easily-although farmers tend to be spread out geographically- and the per capita tax on others to finance the subsidy to small groups tends to be smaller than the per capita cost of subsidizing large groups.
Whatever the explanation, experience has shown that it is difficult to eliminate, or even greatly cut back, farm subsidies in richer nations. There is more hope for being able to change the subsidies to ways that are less discouraging to agricultural imports from poorer nations, that do not mainly help richer farmers, and that do not raise food prices to consumers. Possibilities include the equivalent of an earned income tax credit to fulltime farmers who make low incomes, lump sum income payments to farmers, and possibly greater support for education in farm areas. While the best politically feasible alternatives to present policies are not so clear, it is obvious that the present system of farm subsidies in rich nations is a lightening rod for conflict in trade talks with third world countries, while they help their own farmers in highly inefficient ways.

Comments

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I do not think the farm lobbies alone are nearly strong enough to ensure the continuation of our tragic farm subsidization policies; instead I think the blame rests on ordinary citizens who naively condone subsidization because they like the idea of helping farmers.

If one looks at within country opportunity cost of farming then using the benchmark of world prices for agricultural commodities is debatable. If one looks at comparative advantage of nations, then need for farming subsidies is simply not there.

I have not difficulty understanding why farm subsidies is a bad policy for the United States or other rich country (except maybe in the few cases where there is a positive externality like in Switzerland).

I have, however, more difficulty understanding why farm subsidies hurt poor countries. They can buy cheaper farm products thanks to these subsidies, can't they ? It is true that if Americans are poorer (because of the subsidies) they might not give as much money to poor countries, but the effect does not seem important.

In other words, because of farm subsidies the world will be poorer, the rich countries will be poorer but it is not clear to me that the poor countries will be poorer.

LB
I think the reason poor countries suffer is because in poor countries agriculture constitutes a far greater percentage of the economy. Many of these countries do not have the educated labor pool for more complex industries, so when they are displaced from the world markets for agriculture (at which they have a comparative advantage) they cannot simply move that labor into other industries (where they probably don't have a comparative advantage). Thus, even though technically they can buy cheaper agricultural products, you must remember that a farmer must make money first to buy those goods.

NB: if poor (rural) countries cannot sell their agricultural products to rich (industrialised) countries, they have nothing to trade in for the goods the latter make (consumer goods and capital equipment).
And Harris pointed out, if they cannot buy the cheap (subsidised) farm produce from the rich, because they have nothing to trade in for that, either.

Today's discussion was particularly dismal, as are any discussions which reveal our political system's tendency to opt for the worst alternative.

I wonder if any politician could be successful at triangulating the farm lobby (as suggested by the post's conclusion). And even if it could be done, who's going to take that kind of chance, where's the potential for political gain?

Your paragraph on the motivation to preserve a way of life was, to me, particularly to the point of the motivation behind the issue, at least from the perspective of the empathetic voter and those living in more rural areas of our country.

You say: "The argument is sometimes made that farm subsidies are desirable to encourage small farms, and the way of life on these farms. Yet this claim is contradicted by the evidence available for many decades, and confirmed again in the OECD report, that the vast majority of subsidies go to the largest farms. In many cases they are given to people who own but do not farm their land."

As someone who grew up in the 80's and 90's on a corn and soybean farm, I agree with your analysis of the benefactors of much of this funding. It is typically the savvy, already successful, larger farmers (or owners) who "find a way" to benefit from the subsidies. However, isn't the "real" or most difficult question the one that asks "What system CAN we employ to preserve this way of life?" I think (or perhaps "admit") that this is / would be an effort at protecting those amongst us who are least effective at what they do. But what do they do?

My upbringing and my undergraduate education at the U of C have shaped my view on economic policy. While "efficiency" is something that I respect and value, there are those things for which we are (presumably) willing to trade some part of that efficiency. While I believe that your analysis is accurate in some sense, I think you fail to account for some product that is not agricultural in a physical sense. It is that lifestyle, community, way of life, and happiness that is produced in small towns across the United States. (perhaps similar to the reference to tourism on the countrysides of Switzerland) What do farmers do? Yes, they grow crops, raise animals, and feed their neighbors, but farmers of a particular sort (small ones) do something more - they make small communities possible.

My question, then, is this: to the extent that lawmakers, voters, or others with the ability to influence policy VALUE this product, what mechanisms, strategies, or policies CAN they employ (because subsidies in their current form are not working) to protect that which they value? It seems to me that these benefits are realized by more people than those buying American beef.

The asteroid orbit near (close but not too close) to earth on July 3rd is a good reminder about Judge Posner's book called "Catastrophe." The implied probability based on spending to prevent damage according to risk utility is a good reference point. Hopefully, Judge Posner will comment on this phenomenon in light of the current event, if he has not done so already.

Like everything, small communities will be produced in proportion to their private value and do not require subsidies to survive. Individuals may well be willing to trade income for lifestyle by moving to small communities, and many people do. That is, however, no reason to compell taxpayers to indirectly prop up these communities, for two reasons: a) there is no reason to value the "output" of small communities any more or less than the output from other forms of organization in the economy, or other goods, and b) small communities, like other forms of organization, do not need subsidies to exist.

Your claim that farms make small communities possible is plainly wrong, since many small communities exist without them (e.g. in national parks), and where they do rely on farms, many (most?) farms will continue absent subsidies anyway.

Precisely your argument could be (and is) used to demand public subsidies for anything in the economy: wine, car manufacturing, oil etc. The argument fails because it imposes the values of a few on the many, and is arbitrary in the sense that whatever good is being promoted as special actually isn't - except in the eyes of the few.

If living in a small community is as spectacular as you say it is, then surely Farmer's would be willing to give something up (income, say) for the priviledge of their small-town lifestyle.

City-dwellers hardly benefit from the farmers' small town lifestye, so forcing them to chip in for that new tractor seat hardly seems fair. Also, don't forget that city-dwellers already subsidize you country folk through the construction of roads, power lines and water pipes into the middle of nowhere. In my country, (a few blocks north of y'all) our feds have pledged to deliver hi-speed internet to every igloo, teepee and ice-fishing hut in the country even though there are more square miles than people in many of our northern regions.

The distribution of seats in our parliament (congress) also heavily favors rural communities, to the point that my vote is about 1/2 -> 1/5 as significant as Joe Dirt's.

Bottom line, those who prefer tumbleweed and general stores have been getting a free ride from those who don't since man created the two-story building.

Prof. Becker's citation of academic analysis of small-group politics as an explanation for rich countries' subsidies to agriculture is painfully obtuse, and helps explain why farm subsidies in this country are so hard to get rid of.

The major support for farm programs in the United States is the most basic and most powerful force in human affairs: inertia. Almost all the major commodity programs (the one for oilseeds in an exception) have been around in one form or another since Franklin Roosevelt's second term. The "permanent law" authorizing farm programs (to which the terms of said programs would have to revert if Congress failed to pass a farm bill on time) is an Act of Congress enacted in 1949. Then, agriculture was the largest segment of the economy, employing vast numbers of people in thousands of rural communities.

We live in a very different country now, but it takes far more effort to end or cut back and existing programs than it does to block a new one. Major comets pass near the earth more often than minor federal programs lose their funding, a fact that applies to much more than just the Agriculture Department. Congress is always sensitive to charges that it is "singling someone out" -- taking away traditional benefits from farmers without cutting other spending, or from one group of farmers more than others. It is much less sensitive to grievances of those farmers who grow apples, say, or raise horses, because these farmers have never received subsidies before. Fundamentally, the stumbling block is not inequity, but change.

In the physical world, great force is required to overcome inertia. It is the same in politics. Ending farm subsidies will only be possible in the event of some great crisis demanding extraordinary measure -- a crippling fiscal imbalance, perhaps, or (this is admittedly now a theoretical possibility only) the conclusion of a global trade agreement from which larger sectors of the American economy would benefit if US farm subsidies were withdrawn. Even then, ending farm subsidies would require the support of a group of legislators and other public figures thoroughly familiar with the terms and costs of farm programs, and also with the reasons they enjoy the support they do -- and, finally, who are committed to cutting government spending.

We don't have any of that today. It's small consolation that the inertia supporting Japanese rice protectionism and the French-driven European farm subsidy structure is even stronger than the inertia here.

I think farm subsidies could be compared to oil inventories for emergencies. Although the US is a poor example, think of Japan. Japan is an island where left with no subsidies, Japan's domestic food production would probably not support 1/10 of its population because of land costs alone. So during the highly unlikely chance that all trade routes become blocked, Japan would starve very quickly.
Just a thought.

I'm not an economist by training, but I like to learn about economics. I can understand how import quotas and tariffs allow our domestic producers to raise prices. But I don't understand how subsidies allow our producers to sell at lower (or higher) prices. Can somebody explain in plain english the relationship between subsidies and prices, and the negative economic consequences behind subsidies (higher taxes for the rest of us? Distortion of markets?). I was always hear economists say things like subsidies hurt foreign competitors, but why? It's never really explained.

alvin
I'll try. But I am an economist so plain English doesn't come to me naturally.
Anyway, the basic point is that subsidies are payments from the government to the producer. In this case, the government pays farmers to produce agricultural goods. In this scenario, the producers' income consists of subsidy+market price, market price being the price at which they can sell their products. Now, usually, the problem arises when producers are less efficient than their foreign counterparts, that is, if their cost of producing is higher than the foreign cost of producing the same good. In this case, without subsidies, the domestic producer would stop producing because his costs are higher than the market price he could get. However, with the subsity, he can lower his price below that of foreign competitors. Thus, his foreign competitors are priced out of the market, and the domestic producer stays in business despite his relative inefficiency. This hurts foreign competitors for obvious reasons. It is also bad for domestic consumers: even though they pay a much lower price [the low price domestic consumers select to price out foreign competition] they also have to pay the taxes that pay for the subsidy.
You are also right to note that this leads to market distortion: a producer of a subsidized good, assuming the good has no positive externalities, will produce too much of that good. This is happening in the US now, for example, with corn. Corn is so cheap because of subsidies that corn syrup is used as a sweetener and corn is fed to cattle, both of which have adverse health effects on humans in the long run. Subsidies thus lower the prices and lead to overproduction of certain goods.
I hope this was at least somewhat clear. It's much easier with graphs and terms like "dead-weight loss," but I hope this simplifies it somewhat.

In New Zealand, a country traditionally quite heavily reliant on agriculture, a complex and indulgent set of subsidies were built up until 1984. Those included 'supplementary minimum prices' In 1984, however, a reforming government swept them aside in one fell swoop. A furious response ensued, but farming did not collapse. In fact, more than 20 years on, the local farms are as competitive internationally as ever. US farm policy makers might want to look into the case.

One thing that does remain in NZ from the regulatory and subsidy days is producer boards, which are state entities that control exports. The wisdom of such structures is off the topic, however, since they are not subsidies but rather state control of sales.

Sir:
Before retiring, I worked for the US Department of Agriculture. In that job, I enjoyed from time to time reading the Congressional hearings for the Agriculture and Related Agencies. I remember reading several times the the primary Federal interest in supporting the food, fibre and forestry industry was to provide cheap, healthy and plentiful products to our urban areas, keeping the urban areas peaceful (no food riots) and productive. Another set of statements revolved around providing plentiful food, fibre and forestry products in support of nationa defense. On a recent visit to a local grocery, I found greens, fruit, and other produce from all over the world. I suggest the first arguement in favor of price supports has been overtaken by modern transportation systems and reduced trade barriers. I suggest the second arguement to still have some validity.

The argument against subsidies by the underdeveloped nations of the world in diplomatic talks is disingenous at best. It's really an attempt to drive up world food costs so that their inefficient and incompetent food production systems are competitive. What they really need to concentrate on is becoming food production self sufficient.

The reason why subsidies are granted, at least in the U.S., is to keep arable farm land in production and lower food costs. If "natural market mechanisms" were allowed to operate, 25 to 35 percent or more of arable farmland would be taken out of production to allow prices to float to new higher levels to cover the cost of production.

The question now becomes, are we willing to allow a loaf of bread to climb from $2 to $6/$8 dollars a loaf? As for the issue of energy independence and ethanol and bio-diesel production, this adds on a whole new dimension to agricultural production pricing.

Although deviant in this forum, the response from New Jack seems all too frequent among 'city dwellers': JOE DIRT (his words)farmer apparently is a sad welfare case, sponsored by those hard working honest urbane 'cowboys'. LOL The city folk must subsidize their dirt ball cousins with 'roads, power lines, and water pipes'.

Hee Haw! Pass me the corncob pipe.

Roads? How many miles of road go to supporting urban dwellers? How are those roads used by the farmers? Perhaps a mite, as farm to market roads bringing those delicious salads to the city?

Power Lines? How much power is generated in the metro areas? From all those hydroelectric damns, nuclear plants, and coal plants in the heart of Manhattan I suppose, sending the juice out to Peoria.

Water pipes? Again, I must be missing all those wells, reservoirs, and aqueducts emanating from a city like Los Angeles to Sierra Nevada. Isn't that the way it works water FROM LA to the Sierra Nevada?

Seems to me that the pipelines for water, power, and food is directional from rural to city. The country could survive just fine without the city; the inverse in not true.

As mentioned in the Becker post above, farm subsidies go to the richest 'farmers'. Of the 12-30B of subsidies going to farms, 66% goes to the richest 10% of farmers.

110M of subsidies to Riceland Foods is more than farmers in 12 states combined receive. John Hancock, Chevron, and Caterpillar all receive farm subsidies.

The issue of farm subsidies is a complex and important issue. However, please understand that these monies are not generally going to support Mr Haney and Fred Ziffel out there in Hooterville.

(and boy howdy, I wanna see fellas like New Jack go out and kill and dress their own meat, and grow their own tators...might be slim pickins...pass the possum pie!)

Though barely related to the topic of farm subsidies, a subject on which I find myself in basic agreement with both Judge Posner and yourself, I wonder if I could beg you to comment on "checkoff" programs such as the pork industry currently has. I live on a farm and even the generally conservative farmers (surprisingly, they would agree with you on subsidies and ethanol) love the pork checkoff program. Pork prducers currently (through some legislative act or another) pay .4% to this program whether they want to or not, for marketing and lobbying purposes. Even if it's benefits are great, I'm uncomfortable with the compulsivity involved.

N.E.
I won't argue the numbers, thougt I think they're exaggerated. But:
The developing world, while inefficient at agriculture in absolute terms, they still have a comparative advantage in food production because their costs are so low. While it is probably true that a removal of subsidies here would increase prices [though probably not triple them], prices would increase until food was bought at the world price while our tax bill that pays for the subsidies would become much smaller. [That's not actually true: the tax money would just go to something else. But if we had competent government...]

GRG: The LA is example is a good one, and another good reason for us to get rid of LA altogether. But the city does subsidize much of the infrastructure in the country. Imagine how many people a mile of road connects in a big city vs. how few it covers in a rural area, and yet the costs are shared between the two. Urban taxpayers end up paying a big share of rural roads. This is not a bad thing, necessarily, but it happens.

The argument against subsidies by the underdeveloped nations of the world in diplomatic talks is disingenous at best. It's really an attempt to drive up world food costs so that their inefficient and incompetent food production systems are competitive. What they really need to concentrate on is becoming food production self sufficient.

This is wrongheaded from start to finish. Have you not heard of comparitive advantage? If the comparative advantage of developing countries is not in labor-intensive production like agriculture, then where is it? Self-sufficiency not only guarantees low or zero growth among developing nations, or indeed any country that takes that path, it is a receipe for famine.

The reason why subsidies are granted, at least in the U.S., is to keep arable farm land in production and lower food costs. If "natural market mechanisms" were allowed to operate, 25 to 35 percent or more of arable farmland would be taken out of production to allow prices to float to new higher levels to cover the cost of production.

Again, wrong. Subsidies raise the cost of production by bringing high-cost land into use that would otherwise be used for other unsubsidised activities. The 25-35% figure is certainly wrong based on examples where subsidies have been removed: farming continues, although the mix is different.

The question now becomes, are we willing to allow a loaf of bread to climb from $2 to $6/$8 dollars a loaf?

The implicit argument here is that N.E. would rather pay $2 a loaf and see developing countries denied a chance to develop than to pay more and give them a chance. How repugnant. Even if you accept the exaggerated figures he provides, the argument doesn't stack up, because the majority of first world consumers can afford higher food costs, and there are less damaging means of supporting those who can't than to artifically lower world prices and prevent development in the third world.

To All, "Subsidies raise the cost of product." Do they now? We own the land, we control the lands use. If we so desire, we take it out of production, create scarcity and drive up costs. It's all about money in our pockets, such is the natural market mechanism at work. Until someone figures out that it's really all about "Bread and Circus'es" ;)

"The beautiful views of cows and sheep on the very green Swiss mountains are courtesy of the Swiss government that pays farmers generously to keep these animals grazing on the mountains."

Let's try to be as precise as possible: the courtesy is from taxpayers who pay the government who pays farmers to maintain those pricey farms. Taxpayers/voters have choices to make each election: fund expensive (and seemingly nostalgic?) farms or fund something else. Too bad those choices seem unduly influenced by small groups who might lose a lot.

On another topic, let's look at unemployment rates and incomes (rural, urban and total) after subsidies have been cut (or imposed). We would want to find a way of measuring the loss after subsidies have been cut that special interest groups claim would be devastating, and a way of measuring the gains from market based activity.